The assessment of the domestic macrofinancial linkages of the strategic asset allocation (SAA) of commodity-based sovereign wealth funds (SWFs) often constitutes an integral part of their design and establishment. Many commodity-rich countries that accumulated sizable sovereign assets in the past few years have set up different SWF-type arrangements with objectives related to fiscal stabilization, intergenerational saving transfers, support for future pension liabilities and social priorities (IWG, 2008).
Within the institutional framework that an SWF operates, the macrofinancial linkages of its investment strategies that need to be analyzed pertain to its relation to the government budget, monetary policy and exchange rate movements. We use a simple Markowitz-model framework that integrates the specific objectives and constraints of an SWF and the country's specific characteristics and macroeconomic vulnerabilities, especially with respect to commodity prices and prospective defined liabilities, to derive the optimal SAA. Thus, this methodology is key in providing an SAA that adequately incorporates these macrofinancial links.
In most cases, an SWF's SAA and investment guidelines are specified by the government (the owner of the SWF). In this context, our goal is to develop a model-based SAA framework to assess the macrofinancial linkages of an SWF's SAA, given the SWF's specific objectives and constraints. In particular, we describe the analytical assumptions based on the funding and spending rules for an SWF, select a set of asset classes for the investment decision process based primarily on the objectives of the SWF, and specify the Markowitz-type SAA model for the choice of the specific assets. Based on this analysis, we develop an illustrative asset allocation. It should be noted that the standard mean-variance framework to be used in selecting an SWF's SAA allows us also to assess whether its objectives and macrofinancial constraints are consistent.
Contents
I. Introduction
II. Institutional Arrangements of an SWF
III. Macrofinacial Linkages of the SWF Management
- A. Government Budget
B. Monetary Policy
C. Exchange Rate Issues
D. Public Sector Balance Sheet Effects
IV. An Analytical Model for the SAA Determination of a Stabilization SWF
V. Practical Aspects of an SAA Methodology
VI. Illustrative Application
VII. SAA Considerations under Crisis Periods
VIII. Concluding Remarks
References
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Macrofinancial Linkages of the Strategic Asset Allocation of Commodity-Based Sovereign Wealth Funds
